I'm Lead Analyst at European Energy Review and consultant to a number of governments & institutional investors, most recently as Senior Research Fellow, Netherlands Institute for International Relations (Clingendael), I was previously Senior Research Fellow at ETH Zurich working on energy and political risk. I started work in the City of London, advising on energy markets and political risk, as Senior Energy Analyst at Datamonitor for leading global utilities, and headed up the Global Issues Desk at Control Risks Group, specializing in political risk, geopolitics and security analysis for multinational companies, governments and institutional investors. I was also seconded to work in Washington, D.C., to enhance CRG's political risk offerings in North America, having previously worked as an energy consultant at Weber Shandwick Worldwide. My initial stomping ground was British Parliament, serving as Policy Director to the largest All Party Parliamentary Group. Contact m.n.hulbert.03@cantab.net

Obama Ground Zero: Why Cheap American Energy Is The Death Of American Power

US President Barack Obama walks past an oil rig to a stage to speaks at an oil and gas production fields on federal lands March 21, 2012 near Maljamar, NM. (Image credit: AFP/Getty Images via @daylife)

Good. U.S. elections are out the way. It’s back to the serious business of government. Following years of anxiety over the seemingly inexorable rise of China and the relative fall of the U.S., many now expect that the energy boom in America is going to adjust the balance back in Washington’s favor. Conventional wisdom tells us that America can reinvent itself as an energy giant, vastly reduce its deficit, stimulate its economy, and pick and choose how far it underwrites global hydrocarbon security. Superpower status has been extended for another hundred years (or more) in what’s been coined the ‘New American Century’.

Unfortunately, those writing this perfectly shaped script have missed a fatal subplot when it comes to cheap U.S. oil: Economic gains for America will only ever be marginal for a post-industrial country, whereas for China, it will be nothing short of an import miracle. If America forges ahead to become the world’s largest oil producer in the next five years, mirroring what’s already happened in natural gas, OPEC will have little option but give up on price, and go for enhanced volume instead. In a new world of cheap energy abundance, the only real winner is China, hands down. Far from being Washington’s global salvation, cheap energy will be its instrumental to its nadir. ‘Obama ground zero’, it starts here.

America As Number One?

The clock is already ticking for the U.S., precisely because it’s seeing liquid gains that have already played out in the gas world. After a secular decline from 1986 to 2008 that left America importing over 60% of its oil, the turnaround has been staggering. Production growth has averaged 500,000 barrels per day over the past four years, with liquids output set to hit a massive 11.4 million b/d into 2013. What’s more, despite Mitt Romney’s ‘drill baby drill’ ticket, it was never really going to matter who won the White House in November 2012 – both candidates were always going to keep looking to energy as the main economic catalyst for America.

Some 60,000 wells have been drilled in the U.S. since President Obama first took office, and the numbers will keep going up towards 2016. This has fundamentally been driven by the private sector that went after dry gas first, and it’s now moved to wets; hardly a party that the Federal government has any interest in wrecking. American liquids production stands at a 14-year high; imports are down to 41%, figures that could drop as low as 35% in the coming years – and significantly lower – if transport efficiency and switching measures kick in. Production is still fractionally below Saudi Arabia, but few doubt that under ‘business as usual’ American production will leap towards 13-15 million barrels a day over the next five years. Uncle Sam reclaims its mantle as the largest energy producer in the world. Balance of payments improve, the deficit is fixed, oil flows North to South across the Americas, never East to West across the Atlantic. America is back. And it’s big.

Sounds great, and even better when the message is relayed by the energy independence ‘coterie’ dangling the prospect of ‘1.6 million’ new energy jobs; but let’s stop there for a minute and ask what really happens if America goes headlong into becoming the world’s largest oil producer? Nobody wants to think about that side of the equation when the overriding aim is securing ‘energy independence’ – but think they must – precisely because American energy gains are going to come with a wealth of downside geopolitical baggage. The most fundamental of which is that it’s neither in Washington’s transitional interests to shift the energy pendulum West, let alone forging a new energy world where hydrocarbons are structurally cheap.

This is a comparative game that America needs to play with China as its only rival to the global throne. Not a race to the ‘bottom of the barrel’ that delivers a pyrrhic ‘victory’ for the U.S. while handing over all the geo-economic and geopolitical keys to China.

Transitional Friction: Collateral Damage From U.S. Shocks

Transition issues first. While it’s true that America is already a net exporter of oil products, even if the U.S. surpasses Saudi Arabia to become the world’s largest single oil producer, it’s never going to be in a position to act as the ‘swing producer,’ dictating how much everyone else should pay for a barrel of oil globally. U.S. volumes relative to domestic demand simply aren’t there to play that game. Rather, Washington’s ‘pricing power’ will be limited to the collateral damage it does to traditional producer states, not as a definitive geopolitical and geo-economic pricing tool that America can use at its instant disposal.

The fact that America can never be the ‘new OPEC’ isn’t all bad of course; it would be rather awkward dictating to Europe and Asia how much they’re supposed to pay at the pumps. But it doesn’t negate the ‘collateral problem’ America has here: U.S. oil gains aren’t just a ‘blunt instrument’ for Washington to play with, it’s a very dangerous one. Despite the current $20-25 spread between WTI and Brent, everyone knows that no single nation can insulate itself from global price pressures and shocks. But the ironic thing is that it’s America who’llbe delivering the main ‘supply side shock’ for everyone else to cope with in the next couple of years. With (700,000b/d) production gains showing no signs of easing from Bakken, WTI will have to be fixed as a ‘broken benchmark’. Once Cushing gluts are drained, pipes are welded and oil companies selling oil to the highest bidders, WTI-Brent spreads won’t just narrow, America will start influencing global price bands elsewhere.

The Seaway pipeline has been reversed to link Southern American states to Cushing; the Keystone XL pipeline will be signed off into 2013, feeding Alberta tar sands to Texan refineries, alongside a raft of barges, lorries and trains all making their way to U.S. ports. Don’t worry about developments in the ‘Gulf of Aden’; it’s the ‘Gulf of Mexico’ that international producers need to worry about for oil markets.

That’s going to be deeply problematic for ‘traditional’ producer states. The last thing they need is U.S. crude driving down international prices below $100/b thanks to rapid supply growth, acutely responsive to variable costs. OPEC states – just like FSU players – are all banking on three figure oil to balance their fiscal and budgetary books. Despite coining $1.026 trillion in 2011, and likely to net a record $1.16 trillion in 2012, OPEC states are desperately trying to cling onto power. Petrodollars have to be spent appeasing restive populations with houses, wages and subsidies, buying political support, paying off the military, bureaucracy and intelligence services. Quoting the geological cost of production is frankly irrelevant these days; it’s the geopolitical costs of survival that petro-states have to think about.

With the Arab Spring morphing into a ‘Salafist Séance’, that certainly applies to Saudi Arabia struggling with Shia unrest in its Eastern Province (not to mention Yemeni implosion to the South). It applies to daily crackdowns in Kuwait; it applies to an increasingly heavy handed UAE; it applies to a fractured Iraq; a splintered Libya; a nuclear bent Iran, and an explosive Nigeria. Not to mention corrupt Algeria and Angola – a politically divided Venezuela – and an increasingly nervous Russia. The IMF thinks that the Gulf Cooperation Council will be running fiscal deficits if prices slip below $100/b and government spending continues to rise. ‘Cash rich’ is a relative term these days, even for Gulf monarchies. For those facing internal secession issues the political implications don’t bode well, especially if they’re working on the spurious assumption that power can still change hands behind ‘closed doors’ without the Arab street having a say. But it’s not just traditional producers that have a vested interest in three figure oil prices. The list goes far beyond into emerging energy players facing technical challenges to bring oil to the wellhead. Think Brazil, East Africa, Australasia and even Canada.

Now, at the expense of making the energy independence crowds’ case for them, many will indeed say, well, what’s the problem? This is exactly what we want. America can relax. Sit back, pick and choose what it decides to do to underpin global oil supplies and where, pretty much as it’s done in Libya and Iran (albeit in very different guises). America uses its energy growth to keep traditional producers on their toes and emerging markets firmly in their hydrocarbon place. All partially true – but there’s no free lunch here – not even a free entrée I’m afraid. Like it or not, American energy gains create three serious political problems for Washington. The first is that their own production growth will add far further volatility to international oil markets – volatility that American consumers will still have to pay for. Given America will have no ‘petro-friends’ left to speak of after throwing its energy weight around, whether the Saudis will bother moderating markets on the road to U.S. energy serfdom, as they did for the 2012 Presidential elections, remains highly unlikely. U.S. supply growth is fast, but it’s never going to be as quick as control valves on OPEC pumps if they feel their market position is threatened.

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The problem with these production growth extropolations is that production growth has clearly been driven by high prices. However, the fact that production growth has not driven prices down shows that this gorowth is unsustainable. High prices have caused a frenzy of extraction of previously unprofitable hydrocarbons. The marginal cost of this production is several times higher than the average marginal cost decades ago and this cost is only going to increase. Price reponse to production in recent years is perfectly in keeping with the peak oil scenario.

Respectfully, this is one of the most nonsensical articles I have ever read. There are cases to be made that might support a reduction in the US drive to maximize production. Your illogical conclusions reads like a failed Clancy manuscript.

Please, please, get some oil literate writers. This preposterous article predicts that U.S. oil production is up to 11 million barrels per day. Please just check the EIA figures – Oil production is up to 6.2 million barrels per day. This writer is quoting all liquids because he doesn’t seem to know the difference.I had to stop reading in the 3rd paragraph.

Many thanks for the comments – Benjamin your question is an interesting and something I’ll give more thought as to whether a carbon tax would have any impact on this. I suspect it would touch most in the coal / gas interplay on exports. Matthew, the interesting thing on unconventional costs is that they tend to have high variable costs, so are actually very sensitive to price – I agree if prices fall production will of course be lost, but forget peak oil – it’s gone. As for Clancy novels I’ve never read them Mike, but ask the basic question who gains most from cheap energy, and the collateral impacts U.S. supply growth has elsewhere – once WTI is fixed, the gas world gives us some telling insights. Sandra, the numbers quoted are in indeed liquids, it never states anything other. Jumping on the EIA website doesn’t necessarily make you oil literate – quite the reverse, perhaps. Best, Matthew

This article is specious at best. I won’t go and try to deconstruct the convoluted maize the author maps out for how cheap energy may be bad for the U.S. and great for China. Sure China would like cheap energy and so would the U.S. Expensive energy is a regressive tax on the American working class. So rather than Fisk the argument, I’ll point out a couple of holes in his argument.

Expensive energy also a lost opportunity for the middle class as well. Already inexpensive natural gas has created an abundant feedstock to drop the price of plastics here in the U.S. so much that it offsets high labor costs. The U.S. no longer needs Chinese surfs racked up in barracks at Foxconn for affordable consumer products.

The author also forgets the oncoming advent of 3D printers. When they start to come online, the need for Chinese produced products are even less necessary. Why ship feedstock across the ocean to have little surfs slap together products and ship them back? It seems like a waste of time and money.